EC Monetary Collapse
THE European Monetary System collapsed yesterday. In a meeting to deal with a speculative rampage on the foreign exchange markets, finance ministers of the European Community agreed to allow their currencies to rise or fall in value against each other by as much as 15 percent. That, in effect, means the price of European currencies will "float" on the foreign exchange markets according to demand and supply. The range between the bottom value and the top value of a currency could shift as much as 30 perce nt against another currency before a central bank would be required to intervene in the market to defend its value. A formal devaluation of the currency of an industrial democracy rarely reaches that magnitude. The Exchange Rate Mechanism (ERM) of the European Monetary System, a system created in 1979 to bring currency stability to Europe, had provided for a variation of only 2.25 percent from the nominal exchange rates set for them in the European currency grid.
It could be that at a later date the Europeans will try to revive the ERM by narrowing trading margins again. For exporters and importers in Europe, wide currency fluctuations are a business hazard. Perhaps the central bankers will shrink currency trading margins by informal interventions in the foreign exchange markets. The latter would offer them an opportunity to recover some of the huge sums the banks or the financial ministries could lose because of their vain efforts last week to save the French fr anc, Danish crown, Spanish peseta, and others from devaluation against the German mark. If these currencies remain devalued, private speculators and risk-avoiders could rake in fortunes selling accumulated marks.
Europe's drive for monetary unity put the cart before the horse. It was an attempt to force economic and political unity by currency unification. A more realistic approach would have been to put greater effort into establishing a genuine common market - with smaller differences in living standards between the 12 nations of the Community.
Europe is not yet sufficiently unified for a tight exchange rate mechanism, or common currency. The original planners of the world's economic system did not envisage a free world capital market - just freer trade between nations. Capital movements overwhelmed Europe's system.
Monday's decision is a blow to the French government, which prided itself on an inflation rate lower than Germany. But with a devalued franc, France can lower interest rates.
For Germany, economic recovery is made more difficult. Export companies face a new currency hurdle; imports will be cheaper. Bundesbank stubbornness resulted in a tradeoff: buying lower inflation, but with the risk of a longer recession.